The Predators’ Ball

by Connie Bruck

  But the potential conflicts that could arise in Drexel’s attempting to go both ways were vividly illustrated at this time. Contemporaneous with Drexel’s representing Lear Siegler against the dreaded Belzbergs, it was also representing the Belzbergs as they greenmailed Ashland Oil. Here the Belzbergs reaped a profit of $15.4 million, according to Dorfman. If there was not an ethical dilemma (conflicts of interest are rarely recognized in the investment banking world), such dual purpose might give pause to the sort of client Siegel was trying to bring aboard. Potential clients might wonder, as they disclosed their financials to their investment banker, where his loyalty, or that of his partners, really resided.

  Siegel decided that the best way for his Kidder clients to overcome their fear of Drexel would be for them to become acquainted with his partners, to meet Milken, to understand that true security lay in their being in the Drexel camp, not outside it. So he invited more than a dozen of them to the 1986 Predators’ Ball.

  In one year so much had changed that even the old name, Predators’ Ball, sounded faintly archaic. Among the two thousand guests were many CEOs of major corporations. T. Boone Pickens, the raider who had started it all with Mesa-Gulf, and had been a keynote speaker at Drexel conferences in 1984 and 1985, attended but was not invited to speak (and was clearly miffed). Ronald Perelman, now chairman of Revlon, opened the conference, and Dr. Armand Hammer, chairman of Occidental, closed it. There were also presentations by Beatrice, Gulf + Western, Burroughs, Warner Communications and Lear Siegler. As one of the conference organizers exclaimed excitedly, “It’s the Academy Awards of business!”

  The old ethos was still there, though not as strident and all-encompassing as in years past. In one of the videos that are produced each year at Milken’s direction, Dallas’ J. R. Ewing (Larry Hagman) appeared, flashing a “Drexel Express titanium card,” which, he declared, had a $10 billion line of credit. J. R. urged, “Don’t go hunting without it!”

  But the best line of the conference, most participants agreed, was delivered by Nelson Peltz, who was asked to give a presentation for the first time. A year earlier, Peltz had been a nervous hopeful, with nothing to his name but a controlling interest in a meager wire and cable company. Now he was magically transformed into one of the nation’s industrialists, with a controlling interest in a $4 billion empire. In a play on Winston Churchill’s famous declaration, Peltz gazed out at the crowd, many of them holders of his bonds, and declared, “Never have so few owed so much to so many.”

  Martin Siegel played a prominent role, appearing on a panel and at one point, in reference to his move from the bluenose Kidder to the dread Drexel, donned first a white cowboy hat and then a black. His old Kidder clients, among them the chairmen of Lear Siegler and Pan American, seemed rather dazzled by it all. One guest wondered, “Wow, Marty, does Kidder throw these kinds of things?” But probably no one was more dazzled than Siegel himself. The personal wealth there, he calculated, was three times the GNP. And it was not only the sheer dollars but the power and influence that he found so awe-inspiring.

  One manifestation of that growing power and influence was a political presence far larger than at any previous conference. Senators Bill Bradley and Frank Lautenberg of New Jersey, Howard Metzenbaum of Ohio and Alan Cranston of California all spoke at the conference. Senate Majority Leader Robert Dole was supposed to appear as a surprise speaker at a corporate-finance breakfast, but he canceled at the last moment. Representative Timothy Wirth of Colorado and Massachusetts Senator Edward M. Kennedy came, but they were not speakers. “Kennedy told me,” recalled Tubby Burnham, “ ‘I’m here to listen and to learn.’ ”

  Drexel had spared no effort—and no expense—in educating Congress over the past year and a half.

  Representative Wirth was one of the early recipients of Drexel’s lavish attentions—not surprisingly, since he chaired the hearings of the House Subcommittee on Telecommunications, Consumer Protection and Finance on takeovers, in 1984 and again in the first half of 1985. At first, Wirth spearheaded the congressional assault; but by April 1985, when he attended the Predators’ Ball, he was straddling the fence, and by the end of that year he had become a staunch supporter of Drexel and its junk bonds. In fact, one of his top aides, David Aylward, left his job with Wirth to help organize Alliance for Capital Access, a lobby formed to oppose federal limits on junk-bond financings, formed by Drexel clients at Drexel’s prompting. The leader of Alliance was Larry Mizel of M.D.C. Holdings, a longtime issuer of junk bonds and also a major subscriber to the bonds in the takeover deals.

  Under the Federal Election Campaign Act, the limits on contributions to candidates per election are $1,000 for a contribution by an individual and $5,000 by a multicandidate committee (the category in which Drexel’s Political Action Committee falls). In 1985, Drexel’s PAC donated $2,000 to Wirth, falling short of its limit by $3,000. But contributions by individuals at the firm (including $1,000 from both Michael and Lowell Milken, and $1,000 from Gary Winnick, who left the firm in the fall of ’85) totaled about $17,000. Roughly $9,000 of this was comprised of donations of $250 from members of the Milken group. There were also some contributions from Milken’s extended family. Donations from Tom Spiegel, Abraham Spiegel, Helene Spiegel, Edita Spiegel, Lee Eckel (a Columbia Savings director) and a Columbia PAC totaled $7,150.

  While Drexel executives knew that Wirth was their supporter by the latter half of 1985, Wachtell, Lipton—with Martin Lipton spearheading the anti-junk crusade—apparently did not. In late 1985, twenty members of the Wachtell firm each donated $500 to Wirth—for a total of $10,000.

  By mid-1985, the center of activity for anti-takeover legislation had shifted from the House to the Senate, and Senator Alfonse M. D’Amato of New York, chairman of the Senate Banking Committee’s subcommittee on securities, had primacy. Drexel was by far the biggest donor among financial firms to D’Amato from 1981 to 1986; its contributions totaled $70,750. (The next-highest D’Amato contribution from an investment-banking firm was Morgan Stanley’s at $40,600.)

  As reported by Bruce Ingersoll and Brooks Jackson in The Wall Street Journal, Drexel’s courting of D’Amato moved into high gear at the end of May 1985, when D’Amato was preparing to hold hearings on proposed legislation. One bill would have curbed the use of junk bonds in takeovers and buyouts, and another would have limited junk-bond purchases by thrifts. Harry Horowitz, Milken’s boyhood chum who joined Milken’s group in 1979 to perform administrative functions and by the mideighties was his Washington lobbyist and Predators’ Ball organizer, set up a fund-raising dinner for D’Amato at Chasen’s in Beverly Hills. The guest list at that dinner included twenty-three executives from Drexel and a half dozen from Columbia Savings and Loan, including Thomas Spiegel. D’Amato’s take from this dinner was more than $33,000.

  During the late spring of 1985, the wave of anti-takeover sentiment in Congress was cresting, and many legislators were eager to take some action. According to the Journal account, D’Amato assured his fellow senators that he would have legislation ready to be considered before the summer recess. That, however, did not happen. It was December 1985 when D’Amato finally had his draft bill readied, and by that time the issue had lost its heat. In any event, D’Amato’s proposed legislation carried no provisions onerous to Drexel. On the subject of junk bonds, he suggested a federal study. Five days after D’Amato introduced his innocuous bill, Fred Joseph and thirty-five other Drexel executives each donated $500 to the Senator’s campaign.

  In the end, of the thirty bills that dealt with regulating takeovers in 1984 and 1985, not one passed. While Drexel’s (and other investment-banking firms’ too) lobbying efforts were herculean, at least as much credit for their nonpassage must go to the Reagan Administration, which had said that it would veto any such legislation.

  And the SEC, which was of course the agency most involved, did not support any of the proposed bills. This was hardly surprising, considering that it was the pro-takeover attitude of the SEC and t
he Justice Department (in its antitrust policies) under Reagan that had fueled the M&A activity of the early eighties. The SEC did do a study of junk bonds in takeover financing, which reached the predictable conclusion: Released in June 1986, it stated that there was no “justification for new regulatory initiatives aimed at curbing the use of this kind of debt issuance in takeover bids or indeed as it relates to any other aspects of corporate financing activity.”

  In their 1985 annual report, the President’s Council of Economic Advisers had weighed in with its conclusions, surprising only in their ambitiousness. They purported to settle once and for all the decades-long debate over whether takeovers are beneficial or harmful. This august council concluded that mergers and acquisitions “improve efficiency, transfer scarce resources to higher valued uses, and stimulate effective corporate management.” The conclusion was remarkably definitive but, apparently, more polemical than proven. In some of the more interesting testimony that emerged from the congressional hearings on takeovers, F. M. Scherer, a Swarthmore College economics professor, had rebutted the Council’s findings. In his testimony in March 1985 he pointed out that the report’s conclusion that takeovers improve efficiency relied on stock market event studies, which are short-run in orientation (examining stock prices during periods ten to thirty days before and after the announcement or consummation of the merger). If one looks at a period of ten years or so, Professor Scherer testified, the results are very different.

  Scherer has developed the premier data base in this country for looking at the financial consequences of merger. This data base draws upon twenty-seven years of merger history and seven years of sell-off history for nearly four thousand individual businesses.

  These are some of Scherer’s findings, from his case studies and statistical research:

  • Contrary to the Council’s view that merger-makers sought companies where management had failed, most in fact targeted well-managed entities (such as National Can). What they were generally attracted by was not sick companies or slipshod management but undervalued assets.

  • Takeovers by firms with no managerial expertise in the acquired company’s line of business tended to impair, not improve, efficiency.

  • Takeovers frequently led to short-run profit-maximizing strategies, such as the “cash cow” strategy under which “a business is starved of R&D, equipment modernization, and advertising funds, and/or prices are set at high levels inviting competitor inroads, leaving in the end a depleted, non-competitive shell.”

  • On average, acquisitions were less profitable for the acquiring firms than the maintenance of existing businesses and the internal development of new business lines.

  • Many takeovers led to selloffs, which did improve the efficiency of the simpler, self-standing entity.

  • While Scherer had relatively few hostile takeovers in his sampling, in those he did study he found that the takeover aggravated performance deficiencies that existed earlier.

  In response to questions from panel members, Scherer also made an interesting point about the high-leverage, or debt-intensive, capital structures of many U.S. companies, which are coming to resemble Japanese companies’ financial structures. Indeed, in the gospel according to Milken which is spread by so many of his acolytes, it is often noted that Japanese companies have for years carried much higher debt-to-equity ratios than American companies. True enough, Scherer commented, but the Japanese are able to carry such high levels of debt because when they get into financial difficulties the government bails them out.

  Scherer’s testimony was followed by that of Warren Law, a professor at Harvard Business School. Law too had come to rebut the “glittering generalities” of the Council’s report. The Council’s reliance upon short-run stock market behavior as evidence that takeovers are beneficial, he said, could be accepted only if the stock market were a good judge of intrinsic values. (As Milken and his entire coterie of raiders—who had made billions by identifying assets undervalued by the market—could have told this group, it is not.)

  Law added that he did not believe that it could be strictly proven that takeovers deter or promote growth and productivity. Inasmuch as “we cannot run history twice with and without them, we can only speculate.” With this caveat, however, his speculation is that takeovers decrease productivity. He bases this view on a number of factors. Through takeovers, bigger firms are created, and he believes that large firms “make fewer but bigger errors, tend to continue wrong policies too long, and have the resources to delay until crisis is unmistakable.”

  Furthermore, he pointed out that in the late 1970s approximately half of all corporate acquisitions were also corporate divestitures, many of them businesses which were acquired during the last merger heyday of the 1960s. That wave, he said, was accompanied by “an increasing tendency of executive suites to be dominated by people with financial and legal skills, executives who believed a manager with no special expertise in any particular industry could nevertheless step into an unfamiliar company and run it successfully through strict application of financial controls. The present dismantling of many conglomerates is the result of this folly. There is no reason to believe the result will differ this time.”

  The takeover debate would be laid to rest neither by the 1985 annual report of the President’s Council of Economic Advisers nor by Professor Scherer’s research. While Scherer’s conclusions appeared to be much more soundly based, one reason the debate has been so long-lived is that there is some truth on both sides. Some takeovers do result in more efficient and profitable companies, even when the new manager-owner has no expertise in the industry and has been, as Frank Considine put it, a financial operator, but not an operator—as in the case, thus far, of Carl Icahn and TWA. Some, on the other hand, do result in companies so debt-laden that their R&D budgets are starved and they become noncompetitive—as could conceivably become the case with Uniroyal Chemical, which was the profitable, healthy core of the old Uniroyal and in its brief tenure under Nelson Peltz’s aegis earned barely enough to cover the interest charges on its mountain of $1.06 billion debt. The questions that remain, of course—which of these scenarios occurs more often, and whether there is indeed a preponderance sufficiently quantifiable and large that one can conclude that most takeovers are beneficial or harmful—will not be able to be meaningfully addressed for the most recent wave of buyouts and takeovers for years.

  Despite the reservations that both Scherer and Law voiced about takeovers during their testimony before Congress, neither professor was wholeheartedly endorsing anti-takeover legislation, since both were wary of efforts of the federal government to tinker with the tender-offer process. Law, however, did favor legislation to abolish greenmail. And Scherer was in favor of changing the tax law that favors the issuing of debt over equity by making interest payments (on debt) deductible but dividends (on stock) not.

  No law to abolish greenmail was passed. While sweeping changes were made in the Tax Reform Act of 1986, that debt-favoring provision was not one of them. And the only regulatory measure affecting takeovers that was put into effect gave credence to the view that the government might as well stay out of the takeover arena, since its rules are no sooner passed than they become obsolete.

  In December 1985, the Federal Reserve Board had proposed a measure that would apply its margin regulations to junk bonds issued by shell companies to finance acquisitions. Margin rules restrict the use of borrowed money in buying stock, generally allowing no more than 50 percent to be borrowed.

  As the Fed’s proposal was interpreted at the time, this would mean that buyers intent on financing a takeover would be allowed to borrow only 50 percent of the purchase price against stockholder equity of the target, rather than what had become the vogue in 1985—80 percent or more. In other words, they could no longer buy a company by using the company’s own equity as collateral for loans. It was just such an enforcement of the margin rules which first Unocal (in its petition to the Fed) and later Revlon (in
court) had argued for when they were under attack.

  The Fed’s proposed ruling elicited an extraordinarily vehement response from the Reagan Administration. The Justice Department was joined in its opposition by the Treasury Department, the Office of Management and Budget and others. Even within the Fed there was dissension. Chairman Paul Volcker, who had been an outspoken critic of high leverage and debt-financed acquisitions, was the measure’s driving force, but the two Reagan appointees to the Fed’s board of governors, vice-chairman Preston Martin and Martha Seger, both dissented from the board’s recommendation.

  Wall Street was divided on the measure. Salomon Brothers, for example, was in favor of it, while Drexel of course mounted a blitzkrieg of lobbying against it. Even Milken, who typically did not make the politicking treks to Washington that Fred Joseph, Chris Andersen and others in the firm did, tried to lend a hand. “Milken wanted to come and see the chairman and talk about capital markets,” recalled Michael Bradfield, the Fed’s general counsel. “We wouldn’t let him come.

  “Everybody considered that bad form, trying to initiate exparte contact, trying to get in the back door. It was supposed to be all public comment,” Bradfield continued. In February, after the proposal had been approved, Joseph paid a visit to Volcker.

  The rule was finally adopted, but considerably watered down. The original proposal might have let the government review proposed takeovers based on the respective sizes of the acquirer and the target. But the rule as passed applied only to hostile takeovers by shell companies—and shell companies narrowly defined as having no assets or operations.

  After all the furor, the rule was irrelevant. One way to get around it was to use as acquiring vehicle a company that had some business, however slight. Another way was to use preferred stock instead of bonds. Preferred stock generally acts like debt (it pays an interest-like dividend, and it gives the holder certain rights a common equity holder does not have), but it counts as equity.